CHICAGO, Jan 13, 2003  Investors who swim against the tide and put money into fund types that others are dumping can reap healthy returns. That's the theory behind Morningstar's annual "Unloved Funds" study, which was released today and can be found in the January issue of Morningstar® FundInvestorTM, a monthly newsletter for individual investors.

In the study, Morningstar identifies the three least-popular mutual fund categories from the previous year, as measured by asset outflows. Morningstar has found funds from these unpopular categories have beaten the average equity fund during the next three years more than 75 percent of the time. Moreover, unpopular funds have outpaced popular ones more than 90 percent of the time. Morningstar introduced the study in 1996, after tracing fund flows back to 1987.

"In our 'Unloved Funds' study, we put aside performance measurement and focus instead on how redemptions from a given fund type can often predict a performance rebound," said Christine Benz, editor of Morningstar® FundInvestorTM. "Buying one fund from each of these categories and sticking with them for a few years has been a profitable investment for those who have the patience and willpower to handle contrarian investing."

This year's least popular fund categories include:

Latin America  For the second straight year, Latin America funds got no love from investors, thanks to concerns over Brazil's political and economic volatility and continued instability in Argentina and Venezuela.

Utilities  The blowups of high-profile companies, combined with the declining fortunes of many telecommunications concerns, kept investors far away from utilities funds in 2002.

Financials  Many funds in the financials category felt the sting of exposure to money-center banks, asset managers and brokerages. As their earnings sunk, investors jumped ship.

"We understand that some investors may be skeptical about funds in these categories, but we believe they're likely to turn around in the upcoming years," Benz said. "While the categories that are garnering the most new inflows these days--precious metals, small-value, and real estate funds--may seem more appealing, our research indicates funds from unloved categories for a given year actually outperform popular fund categories during the three following years."

She added, "Even if investors don't follow this strategy, the study is a good reminder that regular portfolio rebalancing can enhance gains and minimize losses. Trimming best-performing funds and reinvesting in beaten-down funds is always a sound portfolio principle, even though investors' natural inclination may be to do the opposite."

Although the unpopular categories vary widely each year, the process never changes. Morningstar suggests investors heed the following if they want to put the findings from its "Unloved Funds" study to work in their portfolios:

Buy one fund from each of the three unpopular groups.Not every downtrodden category will rally during the next three years, so a small stake in each group can make the difference. For example, Latin America funds, which Morningstar named as one of its unloved categories in early 2000, have continued to lag, while precious-metals funds have been strong. Exposure to all three unpopular fund groups from a given year increases the chances for market-beating returns.

Hold for three years.Investors cannot expect immediate gratification with this strategy. Those who bought a precious-metals fund in early 2000 may have been tempted to dump it after such funds posted an average 17 percent loss that year. But, metals funds went on to garner large gains in 2001 and 2002.

Limit the investment.Unpopular categories often dabble in highly volatile markets, so an investor's exposure to these funds should not account for more than 5 percent of a portfolio. Furthermore, although the strategy has been highly successful over the long haul, it's not foolproof: In 1995, Morningstar suggested investors buy funds in the communications, precious-metals, and European-stock categories. Because of a terrible showing from the precious-metals funds, the unpopular group posted a three-year annualized return of only 10 percent--half the gain of the popular funds.

If possible, buy soon.Morningstar studies have shown that, generally, investors can buy the funds up to a year later and the strategy still works. However, all three unpopular categories for 2002 are vulnerable to market-timers; when they swoop in, the stocks can head up in a hurry. In this case, it's best to buy early while stock prices are still low.